South Korea’s Powerful Family Business Ties Could Be Tough to Cut

Lee Jae-yong, center, vice chairman of Samsung Electronics, arriving for questioning in the corruption scandal that brought down President Park Geun-hye, at the office of the independent counsel in Seoul on Feb. 13.CreditPool photo by Jung Yeon-Je

Forget Machiavelli, or “Game of Thrones.” When it comes to staying in power, South Korea’s richest business clans have the game plan down.

There is the charity maneuver, in which family members park their stakes in their business empires in philanthropic nonprofits, letting them keep control without paying heavy taxes.

There is the new company maneuver, in which they create new firms that strike lucrative and friendly business deals with the others they control.

And then there is old-fashioned corporate engineering, in which they merge arms of their empires together to consolidate power, even as other shareholders complain.

With South Korea’s biggest business empire, Samsung, caught up in a nationwide political scandal, a new generation of South Korean leaders has vowed to rip up that playbook. Major candidates in Tuesday’s election for president have said they will clamp down on South Korea’s family-controlled business empires, called chaebol, which dominate the country’s economy and have amassed immense political power.

“Chaebol family control as we know it could end with this generation,” said Kim Woochan, a professor of finance at Korea University Business School in Seoul, the South Korean capital, pointing to an intensifying backlash against inherited wealth. “An opportunity as good as this one is unprecedented.”

But that could be easier said than done, South Korean officials and experts say. While the public blames the chaebol for an embarrassing series of political and business scandals and for holding back the country’s once-surging economy, they continue to hold considerable political power. Their controlling families have also proved adept at finding ways to keep control, even as they face increasing challenges from inheritance taxes, unhappy outside investors and their own family squabbling.

“Leaders, markets, they don’t change overnight,” said Rhyu Sang-young, a professor of political economy at Yonsei University in Seoul. “Every culture has a strong legacy, inertia. It takes time.”

The front-runner in Tuesday’s election, Moon Jae-in, has vowed to stop families from using nonprofit foundations, complicated shareholding plans and other methods to keep control of businesses. One of his main advisers is Kim Sang-jo, an economist known for hawkish views on the chaebol.

But the Democratic Party, led by Mr. Moon, holds only 119 seats in the 300-member legislature, the National Assembly. The Democrats would find it hard to get support from rival parties in passing chaebol reform bills through a fractured legislature, where a pro-business lobby also remains strong. Passing a bill will take many months of wrangling.

Mr. Moon has also promised to make prosecutors more independent and to make it more difficult for a president to abuse the power of the office, limiting the ability of chaebol to collude with the authorities and escape justice. But such reforms would likely require a revision of the Constitution, which would be very difficult to pull off given the nation’s fractious politics.

Mounting distrust of the chaebol culminated earlier this year in the arrest and indictment of Lee Jae-yong, Samsung’s de facto chief, on bribery and other charges related to a scandal that ousted South Korea’s president and led to Tuesday’s election. Mr. Lee, who also goes by the name Jay Y. Lee, is a member of the third generation of a family that controls a business empire that makes its famous mobile phones, builds the world’s tallest skyscrapers — an affiliate constructed the Burj Khalifa in Dubai — operates hospitals, hotels and theme parks, and even offers credit cards.

But frustration with the chaebol has been building for years. Critics blame the conglomerates for a number of social ills, including corruption, inequality and the crowding out of smaller and potentially more innovative businesses. Shares in the chaebol trade at lower prices than they otherwise would — the so-called Korea discount — because outside investors fear founding families will shortchange them.

Family shenanigans have not helped perceptions.

There was Cho Hyun-ah, daughter of the chairman of Korean Air’s chaebol, who resigned from an executive position at the carrier in 2014 over the infamous “nut rage” incident, in which she forced a plane to return to the gate when she was unhappy with the way a flight attendant served her macadamia nuts. There was Chey Chul-won, a member of the family that runs SK Group, who was convicted of beating a protester with a baseball bat. Then there was Chung Il-seon, a Hyundai heir who runs the group’s steel-making affiliate, who was fined by a court for abusing a string of chauffeurs.

Over the long term, many chaebol families have seen their grip on their empires slip. Often, the families have only themselves to blame. A succession fight between siblings broke up Hyundai in the early 2000s. Lotte, another chaebol, went through an ugly war between brothers in 2015. (The winner, Shin Dong-bin, may have seized a poisoned chalice: He has also been indicted on charges of bribing South Korea’s recently deposed president, Park Geun-hye.)

They face other challenges — in particular, taxes. Perhaps surprisingly in a country where dynasties have persisted, inheritance taxes in South Korea are high — for the wealthy, 50 percent or more.

That is where the power-preservation playbook comes in.

One solution has been to transfer stakes in chaebol companies to family-controlled charities. Four foundations controlled by the Lee family hold billions of dollars worth of shares in key Samsung subsidiaries, including the smartphone maker.

Another option is to ensure that chaebol heirs get rich before their parents die. That can be accomplished by setting up small companies under an heir’s control, then making them bigger using the family’s business connections.

Critics say that is what happened at Hyundai Motor, where Chung Eui-sun, the son of the carmaker’s chairman, invested in a small logistics company in 2001. The company, now called Hyundai Glovis, quickly secured lucrative contracts with Hyundai affiliates. Within a few years Hyundai Glovis and Mr. Chung were worth billions. A Hyundai spokeswoman declined to comment on the arrangement.

Mr. Lee of Samsung, who is technically vice chairman but leads the conglomerate on behalf of his ill father, also benefited from maneuvers designed to preserve family power. Starting in 1996, when Mr. Lee was just 28, Samsung companies began issuing him cut-price bonds that he was later able to convert into stock, allowing him to accumulate valuable ownership stakes at a fraction of the market cost. Mr. Lee’s father, Lee Kun-hee, was ultimately convicted of breach of trust in connection with the deals — though he was later pardoned, and the younger Mr. Lee was allowed to keep his shares.

Another maneuver is at the heart of the charges against him. The merger of two Samsung companies in 2015 made Mr. Lee the dominant shareholder in a crucial part of the Samsung empire. Mr. Lee earlier this year was accused of bribing President Park and others to push another major shareholder, the government’s pension system, to approve the deal. Mr. Lee denies the charges and says he was a victim of extortion.

Outside shareholders, which could be a point of pressure, still don’t have a big voice. Many chaebol companies have long been publicly traded, but their size and success has drawn outside investors who clamor for greater say and better governance. In the case of Samsung, an American hedge fund, Elliott Associates, objected to the deal that led to the bribery charges against Mr. Lee. But the hedge fund failed to block it.

“South Korea has to promote the role of the institutional investor,” said Professor Rhyu of Yonsei University, adding that the pension service lacked a culture of independence. “The problem is corporate governance.”

In the National Assembly, political parties have sponsored several bills that would make chaebol corporate governance more transparent and make it harder for their chairmen to help enrich their children through dubious business transactions. One idea pushed by Mr. Moon is to introduce so-called cumulative voting to make it easier for candidates supported by minority shareholders to get a board seat.

But any campaign to overhaul the chaebol would be vulnerable to overall economics. If the economy slows, politicians may fear that constraining the chaebol would hurt business activity.

“There are people who recognize the problem, but also a lot who don’t,” said Professor Kim of Korea University Business School. “There are plenty of people who think, yes, there has to be an owner family involved.”

Correction: May 8, 2017
An earlier version of this article misstated the size of the Samsung Foundation of Culture’s stake in Samsung Electronics. The foundation’s stake is 0.03 percent, not close to 8 percent.